Public Information Notice No. 06/142

Public Information Notice: IMF Executive Board Concludes 2006 Article IV Consultation with Chad

December 21, 2006

On December 18, 2006, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Chad.¹

Background

A three-year PRGF arrangement under the Poverty Reduction and Growth Facility (PRGF) was approved for Chad in February 2005 in an amount equivalent to SDR 25.2 million (45 percent of quota). Chad reached its decision point under the Enhanced Heavily Indebted Poor Country (HIPC) Initiative in May 2001. Attainment of the completion point has been delayed, mainly because of unsatisfactory fiscal performance. Reflecting expenditure overruns and uncertainty about a final agreement with the World Bank on oil revenue management, the first and second reviews under the PRGF arrangement have been delayed.

Despite some progress in macroeconomic stabilization and reform under Fund-supported programs during the 1990s, Chad's indicators on business climate, governance, and socio-economic conditions still remain among the lowest in the world. Although the oil sector accounts for almost half of GDP, and has led to high growth rates during 2001-04, the bulk of the population still heavily depends on cotton, livestock, and small-scale agriculture.

In recent years, the resumption of armed conflict in the region has deteriorated the political and security situation. Real growth has slowed following the completion of the oil pipeline and a fall in oil production owing to technical problems. In 2006, real GDP is expected to grow by 1.3 percent, reflecting higher non-oil growth offsetting a somewhat larger fall in oil production than envisaged earlier. Real non-oil growth is expected to rise to about 6 percent by 2007, in part reflecting a higher level of government expenditure, and then to stabilize around 4.5 percent in subsequent years. Inflation increased to an annual average of 8 percent in 2005 owing to a drought in 2004, and, despite a better harvest, remained high in 2006 because of increasing meat prices. Mainly reflecting the appreciation of the euro against the U.S. dollar, the real effective exchange rate appreciated. After stagnating in 2003-04, broad money grew by 32 percent in 2005 owing to a rise in credit to the cotton sector, but monetary expansion slowed down to about 28 percent by late 2006. The financial health of the banking system appears broadly satisfactory, although vulnerable because of its overexposure to government deposits.

On the fiscal front, the start of oil revenue supported higher domestic spending during 2004-05, partly offsetting a sharp shortfall in budget donor support as reform momentum slowed and performance under the PRGF weakened. Despite the net rise in resources, domestic debt and arrears continued to accumulate, reflecting poor budget discipline and weak public finance management. Fiscal management was also complicated by the segmentation of the budget and cash management.

Budget execution in 2006 has been affected by a number of factors. In January, the authorities' unilateral modification of the Petroleum Revenue Management Law agreed with the World Bank resulted in contractual remedies by the Bank, including the blocking of the offshore oil revenue escrow account. The loss of revenue was partly offset by the start of income tax payments by the oil companies in March 2006. The dispute with the Bank was settled in July and, in October, the settlement of an income tax dispute with two of the three companies in the consortium producing Chad's oil resulted in additional revenue equivalent to 8 percent of non-oil GDP. This allowed a further expansion in most categories of expenditure—including on exceptional security expenditure following heavy fighting with rebels—raising the non-oil primary deficit to 16.6 percent of GDP in 2006.

Reflecting high oil prices, and the agreements to restore normal relations with the Bank, Chad's fiscal outlook has improved substantially. Under the agreements the authorities have prepared a draft budget for 2007 that allocates at least 70 percent of all budgetary resources to priority sectors (excluding security). The budget is formulated in the context of a medium-term expenditure framework, aimed at maintaining macroeconomic stability and fiscal sustainability. In support of this, the authorities formulated an action plan to strengthen public financial management, that is supported by donors. Long-term oil revenue management policies would be discussed in the context of an update of the PRSP during 2007.

Executive Board Assessment

Executive Directors noted Chad's efforts in maintaining macroeconomic stability and in channeling resources to priority sectors despite a difficult political and security environment. Nonetheless, poverty remains widespread, and the economy continues to face major impediments to growth, including inadequate infrastructure, a poor business climate, limited public financial management capacity, weak governance, and the resurgence of armed conflict in the region. In addition, political instability and capacity constraints have contributed to delays in support from donors.

Against this background, Directors urged the authorities to seize the unique—but likely short-lived—opportunity created by the oil revenue windfall to move decisively to establish the foundations for more sustained growth and lasting poverty reduction. They recognized that the authorities face daunting challenges in ensuring the efficient management of revenues while safeguarding macroeconomic stability and medium-term fiscal sustainability. Directors accordingly welcomed the authorities' intention to establish a mechanism to save future excess oil revenues, urging them to ensure that it is fully operational by the end of March 2007, when substantial oil revenue is to be received. They underlined that political stability will be essential to allow the oil wealth to be channeled to the priority sectors. Directors also stressed the crucial importance of actions to strengthen budgetary management, improve the quality and transparency of expenditures, and enhance absorptive capacity. Equally, noting the transitory nature of the oil revenues, Directors called for accelerated efforts to develop the non-oil sector.

Directors considered the 2007 budget and the medium-term fiscal framework broadly supportive of macroeconomic stability, but noted that the fiscal outlook is subject to risks arising from the frontloading of public spending and the unsettled security environment. They encouraged the authorities to remain vigilant to ensure that spending does not exceed absorptive capacity, and to impose tight controls on new medium-term investment projects to ensure fiscal sustainability. Accordingly, a considerable part of the 2007 oil revenue will need to be saved for use in subsequent years.

Directors underlined the importance of strengthening public financial management, including the steadfast enforcement of laws and regulations, in order to avoid a recurrence of unplanned spending and to raise the quality of public investment. The authorities' action plan in this area should be rapidly implemented, for which Directors urged donors to provide strong support.

Directors noted that the debt situation has improved but Chad still faces a high risk of debt distress. To strengthen the debt outlook, it will be important for Chad to aim to attain the HIPC completion point as soon as possible while maintaining macroeconomic discipline.

Directors welcomed the authorities' plan to complete a comprehensive update of the PRSP during 2007. A key element in the PRSP should be a new Petroleum Revenue Management Program (PRMP) that incorporates the revised revenue outlook, and includes provisions for monitoring an effective execution of expenditures and for promoting best practices in public financial management.

Directors considered that implementation of ambitious structural reforms will be crucial for diversifying the economy. Chad's temporary oil windfall should be used to promote the development of the non-oil sector so that it can support the continuation of the poverty reduction strategy when oil runs out. In the public sector, such efforts should include strengthening non-oil revenue as well as pursuing civil service, military, and public enterprise reform. In close cooperation with the World Bank and other partners, the authorities should quickly implement the needed reforms in the electricity and the cotton parastatals, with a view to eliminating budgetary subsidies. It will also be important to carry forward the reforms in the trade system recommended by the recent Diagnostic Trade Integration Study.

To improve the business climate and Chad's external standing, Directors called for strengthening the judiciary and anticorruption efforts. They also welcomed the authorities' intention to strengthen Chad's financial sector, in line with the recommendations of the recent regional FSAP and in cooperation with the Banking Commission of Central Africa.

Directors noted that Chad's membership in the Economic and Monetary Community of Central Africa and its fixed exchange rate regime have provided an important nominal anchor for macroeconomic policies. However, the oil windfall could lead to some real appreciation of the exchange rate. While noting that the rebound in inflation in 2006 was concentrated in food prices, Directors encouraged the authorities to monitor price developments closely and improve statistical information on prices and wages.

Directors encouraged the authorities to upgrade macroeconomic statistics and follow up on the recommendations of the recent data ROSC.

¹ Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.